The world-wide capital markets have undergone unprecedented fluctuations during the past decade in response to changing economic, political and financial conditions. This has created an investment environment characterized by rapidly changing inflationary expectations, high real interest rates, volatile exchange rates, and a fully internationalized capital marketplace. Traditional investment devices such as stocks and bonds have been supplemented with more versatile investment vehicles. Indeed, the advent of computerized trading and other forms of advanced information processing has spawned a new family of investment products. Such newly developed products include: second tier ("junk") bonds; commodity options; international capital, real estate, and currency funds; "unmanaged" index funds; REIT limited partnerships (real estate investment trusts); financial futures contracts, and other so-called derivative instruments on many of these forms of capital. Additionally, the integrated mutual fund family has been expanded to offer a broad collection of separate funds directed to these diverse investment choices.
Mutual funds provide the investor the opportunity to participate in the capital markets at a relatively low fee for portfolio management. Most mutual funds are managed by professional money managers with their fees taken as a percent of net asset value of the fund for a given period. These fees finance the large research departments that sift through and select the various investments for the fund. This management fee often varies between 0.5% to 1.5% of the net asset value of the fund. In addition, mutual funds are a legal cooperative of ownership of the selected securities and, therefore, involve all the legal significance of security ownership to the participating investors without the attendant control thereof.
The professionally managed mutual funds have come under recent criticism due to the fact that a significant percentage of managed funds fail to outperform the general equity markets. Recent studies indicate that a significant percentage of all managed funds were outperformed by the S & P 500 index. The S & P (Standard and Poor's) 500 index is a relative valuation of the stocks of 500 large companies, most of which are listed and traded on the New York Stock Exchange. The S & P 500 index is an indicator of the general performance of the United States equity markets. The relatively poor performance of the managed funds has created substantial interest in unmanaged investment products that track the overall performance of the equity markets unencumbered by asset research fees and high transaction costs. This may be accomplished, for example, through indexed stock funds that invest in the stocks of the S & P 500 companies and, therefore, directly track the performance of the S & P 500 index.
In spite of these alternatives, certain investment strategies remain prohibitively expensive to pursue for a significant number of smaller investors. In particular, many investors employ a technique known as market timing, which involves investing in the equity markets at the perceived time of total market growth and divesting at a later time of perceived market contraction. This strategy is usually based on timing the business cycles for the economy as a whole. The investor pursuing this strategy desires to avoid the risk associated with owning individual stocks.
Somewhat antithetical to the market timer is the investor, who seeks the undervalued stock. This investor desires to negate the business cycles so that the selected individual stock, perceived to be undervalued, has an opportunity to appreciate. This investor, therefore, seeks a means of hedging his investment in the undervalued stock with a countering investment to limit the impact of the business cycle on his stock. This is normally accomplished by investing short in the market (i.e., selling borrowed stock or other assets).
Investor hedging can be expanded to include the broader class of portfolio managers interested in "Beta" management which involves tying the risk level of the investor's portfolio to the overall performance of a selected market to meet the specified risk allotment of the portfolio. Beta management will invariably include both long and short positions in certain assets.
The above-described investors are not particularly well served by presently available investment products. For example, the market timer must buy and sell a grouping of securities to capture the swings of the business cycle--a prohibitively expensive undertaking in terms of transaction costs when dealing with individual stocks. The use of options and futures contracts on stock indices solves some problems and permits the investor to take a short position, but due to the short term nature of these investment products, continuous trading is required even though no change in position is desired.
The advent of mutual funds and especially the "no-load" mutual fund families that combine several individual funds that respectively provide for income or capital growth with no sales charge would appear to provide a low cost investment vehicle to the market timer. The market timer would merely switch from the equity fund to an income fund at a time of perceived weakness in the equity markets. In fact though, most mutual fund families are not designed for active switching and many actually restrict the number and size of switches made by an investor. Many such funds also have the option of redeeming in kind, i.e., redeeming the underlying shares to the investor--an undesirable transaction for the market timer. The restrictions discussed above are specifically designed to inhibit the use of fund families by the market timer. Moreover, investors in mutual funds are by definition, owners of the underlying securities. The ownership of securities involves restrictions and regulations that may place an additional burden on the investor.
In hedging and Beta management, the use of direct futures contracts is prohibitively expensive. Moreover, hedging and Beta management, in part, involve short selling which cannot be accomplished vis-a-vis mutual funds.
To implement the above investment strategies in a cost effective manner, an investment system is required that provides the efficiency and cost of a no-load mutual fund with the versatility of the options and futures contracts market. It was with this understanding of the problems of the prior art that the present invention was made.